Colorado Life Producer License Practice Test

What distinguishes profit-sharing from a 401K plan?

1. Profit-sharing involves mandatory contributions from employees

2. Profit-sharing allows employer contributions based on company profits

3. 401K plans require employers to match funds

4. Profit-sharing accounts are not tax-advantaged

The correct answer is: Profit-sharing allows employer contributions based on company profits

Profit-sharing plans are uniquely distinguished by the employer's ability to make contributions that vary based on the company's profitability. In this arrangement, the employer can decide how much to contribute to the plan each year, if at all, allowing contributions to fluctuate with the financial performance of the business. This characteristic provides flexibility for employers to incentivize employees when the company is doing well, aligning employee rewards with the company's success. The distinction lies in the lack of mandatory contributions required from employees, as well as the discretionary nature of the employer's contributions, which is contingent on the company's earnings. This is what makes profit-sharing plans different from structured retirement plans like 401(k)s, where contributions typically must meet certain criteria and often involve mandatory employee contributions.